INVESTING IT

INVESTING IT; Stock Strategist: Long-Term Losers May Not Be Long Shots

By REED ABELSON

Published: August 13, 1995

IN the search for good stocks, many investors pick past winners, and it is easy to understand why. Who wouldn't be impressed with a stock like Cisco Systems, which has doubled and more in the last year? But to raise substantially your odds of choosing the next year's standouts, bet on long-term losers, said Mark Stumpp, chief investment officer for Prudential Diversified Investment Strategies.

Mr. Stumpp, whose Short Hills, N.J., firm manages roughly $10 billion, reached that conclusion after studying the stock performance, from 1971 to 1994, of the nation's 2,000 stocks with the largest capitalizations.

According to Mr. Stumpp, those stocks whose five-year total returns landed them in the bottom third of their industry group surpassed the top-third stocks in the sixth year of performance. The losers won decisively, by an average of 10 percentage points a year. And while just 25 percent of the top-performing stocks in the first five years achieved a sixth year of outperformance in their group, 37 percent of the five-year losers did so.

But only stocks that have been dogs for five years are likely to outperform in this way. The same pattern does not emerge with stocks that have trailed their peers for only three years, Mr. Stumpp found.

"The stocks get overly depressed over five years," Mr. Stumpp said. "They tend to recover in a year." He also surmised that the odds are greater for a turnaround if a company has disappointed investors for five long years but has managed to remain in business. Those companies, clutching a still-valuable franchise, may have finally appointed a new chief executive, for example, or gone through a painful restructuring.

To produce a short list of possible losers-turned-winners, Mr. Stumpp divided his 2,000 stocks into 16 industry sectors. He then chose the one company in each sector that performed the worst for the five years ended July 31. After stocks priced at $5 or less and those that traded infrequently were eliminated, 13 equities remained.

These stocks are real howlers. Investors unlucky enough to have bought stock in Oryx Energy or Navistar International five years ago, for instance, would have seen the shares fall in value by nearly two-thirds. Oryx, a large independent producer of oil and natural gas, lost roughly $1 billion last year, and Navistar, which makes trucks, has lost money in four of its last five fiscal years.

And the majority of the unlucky 13 have done poorly in the market recently. In fact, despite a raging bull market that has pushed the S.& P. 500-stock index up 24 percent over the past 12 months, Oryx, Navistar, Woolworth, Tenet Healthcare, Echo Bay Mines and U.S. Surgical have still managed to go down in price over the same period. Liz Claiborne and WMX Technologies have simply treaded water.

But a handful of the stocks have performed well recently. ADT, Polaroid, Digital Equipment, USF&G and Delta Air Lines have easily outperformed the market over the last 12 months.

After years of red ink, for instance, Digital Equipment returned to profitability with earnings of $86.3 million on sales of $13.8 billion for the fiscal year ended June 30. The numbers reflect, in part, a massive cost-cutting program that could eventually save the computer company nearly $5 billion a year. The stock has doubled in the last 12 months. And Delta, after four consecutive years of losses, also returned to the black with earnings of $320 million on revenues of $12.2 billion for the fiscal year ended June 30. In the last 12 months, its stock has risen roughly 50 percent.

Nevertheless, plenty of these perennial losers -- including some of the recent rebounders -- may continue to disappoint. About one-third of the poor performers from 1971 to 1994 remained at the bottom of the heap in the sixth year, Mr. Stumpp said. The lesson is that five-year underperformance must not be the only element in an investment strategy, says Mr. Stumpp, who has bought some of the stocks.

Investors must make sure the company's troubles are past. Tenet Healthcare, which used to be National Medical Enterprises, was the subject of a scandal involving illegal kickbacks to doctors. Under new management, with a new name and the scandal behind it, the company bought American Medical International Holdings in March to become the nation's second-largest hospital chain after Columbia/HCA Healthcare. Add to that the potential earnings increases from the merger, and Margo Vignola, a Merrill Lynch analyst, is impressed enough to rate the stock a long-term buy. At $14.75 at Friday's close, the shares trade well below their 1992 high of $25.875.

But even when a company's fortunes have improved, its fundamental problems may not have been solved.

Consider U.S. Surgical, which makes surgical staples and other medical equipment. The company's stock, which fell below $16 last year, has bounced back to $23.375. But while some on Wall Street are hailing the company's return to health, others are skeptical. Although he applauds the company's improved profitability, Thomas Gunderson, a health care analyst for Piper Jaffray, is not recommending the stock. "Almost all the things that made it difficult for the company in the past are still there," he said, citing fierce competition from Johnson & Johnson and pricing pressure.